Should we expect stormy skies or sunshine in 2016?

Family and friends are the natural focus but often in the New Year the mind turns to the investment portfolio - or the overdue tax return for the tardy.

The financial services industry speaks with many voices - a fact well highlighted within the range economic outlooks for the year ahead.

These hefty documents, filled with asset class predictions and experts opining the movements of currencies and interest rates are generally only read cover-to-cover by a dedicated few. However, numerous headline predictions tend to find their way to the mainstream media where they influence the thinking of investors of all levels.

So why would an institution like Vanguard, with such a strong focus on setting and sticking to a strategic asset allocation over the long-term, add to the annual discussion around market predictions? 

From Vanguard's perspective, it's important that investors know what to expect in coming years for the purpose of developing realistic expectations of returns, within the wider understanding that a diversified, low-cost investment portfolio built to withstand and perform across a range of market conditions over the long-term will offer the best chance of success. That is because short-term predictions, including the slew of annual forecasts we will see over December and January, do not make a strong enough case to continually re-jig a portfolio based on current (temporary) conditions.

The reality is that forecasting economic and market trends is a bit like a weather forecast: a weatherman on the news or an app on your phone can give a prediction of what might happen, but even when those predictions are correct, weather conditions can have varying levels of severity.

From Vanguard's perspective, it's essential to offer 'probablistic' predictions which sit within a band of probable outcomes, whether they are economic indicators or market performance.

Vanguard's annual Economic and Investment Outlook, provides a glimpse of what the next decade might hold for the global economy by considering probable outcomes for growth, inflation, interest rates and returns on equities and fixed income markets. A core tool used to develop the outlook each year is the Vanguard Capital Markets Model (VCMM), a proprietary tool that generates probable market performance distributions over 10 years, based on current conditions.

Some of the headline predictions in the Vanguard outlook for 2016 are:

• 'Frustratingly fragile' global economic growth
• 2% -3% base growth of the Australian economy in 2016, with moderate downside risks
• Median expected returns of 7% - 10% for Australian equities over 10 years
• Median expected returns of 2% - 4% for global fixed income assets over 10 years

So, now you have this information, what should you do with it?

The likely answer is 'not a lot', providing your asset allocation is well-diversified, is suited to your personal investment objectives and keeps costs down. The value of having a strong sense of what your target asset allocation is that it should enable you to take a deep breath when market volatility hits and remember that the main game is won over the long-term and short-term impacts are to be expected.

Where the Vanguard economic outlook may prove most useful - given its 10-year horizon - is when you are reviewing your financial plan. It provides a framework to review the longer term assumptions built into your financial plan and could form the basis of a good discussion with your financial adviser.

The core philosophy behind both Vanguard's outlook and the VCMM is that forecasts should give an indication of the likely distributions of economic indicators and market performance, rather than prescriptive predictions, and provide a long-term perspective, rather than a guide on how investors should approach asset allocation year-on-year.

The key thing to remember is that many of the factors detailed in annual economic forecasts are out of investors' control. This fact goes to the heart of why Vanguard's outlook provides probable distributions, rather than specific predictions: at the end of the day, investors should use economic forecasting to temper their expectations of what their portfolio might be subjected to, rather than making significant asset allocation decisions based on news headlines.

Just think of it like your regular weather forecast, which can tell you whether to carry an umbrella, but not how to prevent the rain from falling.

By Robin Bowerman
Smart Investing 
Principal & Head of Retail, Vanguard Investments Australia
14 December 2015